At the meeting of the eight bloggers and the US Treasury, one of the differences was whether the recovery was real or not.? The Treasury officials pointed to the financial markets, and the bloggers pointed at the real economy (unemployment and capacity utilization).
I posted this on RealMoney on 5/6/2005, when everyone was screaming for the FOMC to stop raising rates because the ?auto companies were?dying.?
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On Oct. 2, 2002, one week before the market was going to turn, the gloom was so thick you could cut it with a knife. What would blow up next?
A lot of heavily indebted companies are feeling weak, and the prices for their debt reflected it. I thought we were getting near a turning point; at least, I hoped so. But I knew what I was doing for lunch; I was going to the Baltimore Security Analysts? Society meeting to listen to the head of the Richmond Fed, Al Broaddus, speak.
It was a very optimistic presentation, one that gave the picture that the Fed was in control, and don?t worry, we?ll pull the economy out of the ditch. When the Q&A time came up, I got to ask the second-to-last question. (For those with a Bloomberg terminal, you can hear Broaddus?s full response, but not my question, because I was in the back of the room.) My question (going from memory) went something like this:
I recognize that current Fed policy is stimulating the economy, but it seems to have impact in only the healthy areas of the economy, where credit spreads are tight, and stimulus really isn?t needed. It seems the Fed policy has almost no impact in areas where credit spreads are wide, and these are the places that need the stimulus. Is it possible for the Fed to provide stimulus to the areas of the economy that need it, and not to those that don?t?
It was a dumb question, one that I knew the answer to, but I was trying to make a point. All the liquidity in the world doesn?t matter if the areas that you want to stimulate have impaired balance sheets. He gave a good response, the only surviving portion of it I pulled off of Bloomberg: ?There are very definite limits to what the Federal Reserve can do to affect the detailed spectrum of interest rates,? Broaddus said. People shouldn?t ?expect too much from monetary policy? to steer the economy, he said.
When I got back to the office, I had a surprise. Treasury bonds had rallied fairly strongly, though corporates were weak as ever and stocks had fallen further. Then I checked the bond news to see what was up. Bloomberg had flashed a one-line alert that read something like, ?Broaddus says don?t expect too much from monetary policy.? Taken out of context, Broaddus?s answer to my question had led to a small flight-to-safety move. Wonderful, not. Around the office, the team joked, ?Next time you talk to a Fed Governor, let us know, so we can make some money off it??
PS ? ?Before Broaddus answered, he said something to the effect of: ?I?m glad the media is not here, because they always misunderstand the ability of the Fed to change things.? ?A surprise to the Bloomberg, Baltimore Sun, and at least one other journalist who were there.
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And now to the present application:
Why are commodities rising amid surplus conditions in storage?? Why is it reasonable to take over corporations when it is not reasonable to expand organically?? We are in a position where yields on short? Treasuries are nonexistent, investment grade and junk yields are low for corporates, and equities are rallying, but there is little growth, or some shrinkage in productive capacity.? Why?
The liquidity offered by the Fed is being used by speculators for financial positions, levering up relatively safe positions, rather than speculating on areas that are underwater, like housing and commercial real estate.? This is consistent with prior experience.? When the Fed does not allow a significant recession to occur, one proportionate to the amount of bad loans made, but comes to the rescue to reflate, what gets reflated is the healthy parts of the economy that absorb additional leverage, not the part that is impaired because they can’t benefit from low rates.? They have too much debt already relative to the true value of their assets.
That is why a booming stock market does not portend a good economy.? Banks aren’t lending to fund new growth.? They are lending to collapse capacity through takeovers.? ROE is rising from shrinking the equity base, not by increasing sales and profits.
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There is another current application:
Why do we buy commodities as investments?? Is it that we fear inflation in the short or long run?? Is it that it is a proxy for future prices for consumption in retirement, so we are hedging the future price level in a dirty way?
Think about it.? How do you transfer present resources to the future?? Most consumable goods can’t be stored, or require significant cost for storage.? Services can’t be stored; elderly people can’t store up health care.
Storage occurs through building up productive capacity that will be wanted by other at a later date, such that they will want to trade current goods and services for your productive capacity.? Storage also occurs by purchasing goods that do keep their value, and then trading them for goods and services you need when the time come to consume.
That is how one preserves value over time, and it is not easy.? It will be even harder if there are such disruptions to the economy that markets that are virtual do not survive.? (I.e. paper promises are exchanged, but their is significant failure to deliver at maturity.)
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In an environment where the government is playing such a large role in the economy, it is difficult to see how one can invest for the long term — when we are twisted between deflation and inflation, rational calculations are circumscribed, and simple judgments, such as buying out a competitor and shrinking the overall balance sheet are made.? In one sense, that is the rational thing.? Less capacity is needed.? But unemployment will rise.
That’s sad, but wage rates may be too high for some to be employed, given the lack of demand.? I view this as true in aggregate, but people that are aggressive in seeking employment are able to do much better.? I have seen it.? Even in a bad market, those that strive intelligently get hired.
One other blogger took his nameplate with him — I’m not sure who; the rest left theirs.? But this is what was in front of each one of us as we sat down to discuss matters at the US Treasury.? Treasury officials had similar nameplates.? It dictated where we would sit as well.? From the front of the room on the left, for bloggers it was Financial Armageddon, (Megan McArdle — not there), Accrued Interest, and Across the Curve.? On the right, Naked Capitalism, Kid Dynamite, Interfluidity, Me, and Marginal Revolution.? Aside from putting the two bloggers with the most traffic at the front, there did not seem to be any rhyme or reason to the seating.
The Treasury officials presenting generally sat in front, a few sat to the side and behind us.? It made for an interesting dynamic during the portion of the meeting where some bloggers disagreed over whether derivatives should be exchange traded or not.? The folks from the Treasury grinned.? See?? These aren’t easy questions to answer!? For me, with a middle view (bring interest rate swaps to exchanges first and see how they work, then try other instruments that are less liquid), I found the exchange to be a waste of precious time, but it was revealing of the attitudes of those in the Treasury.? I knew what the bloggers thought already.
Surprise! Over-indebted countries do default on their debt more often than less-indebted countries.? During the current crisis, we have two mechanisms running to blunt the troubles.? The government is running a large deficit, and the central bank is sucking in longer-dated bonds to lower interest rates.? I talked about why lower interest rates are not necessarily a blessing yesterday.? Today’s thoughts are on deficits.
After the meeting, I said to one Treasury staffer, “One of the quiet casualties of this crisis is that you lost your last bit of slack from the entitlement systems.”
“What do you mean?”
“Just this, prior to the crisis, Social Security and Medicare would produce cash flow surpluses for the Government until 2018.? Now the estimates are 2016, and my guess is more like 2014.? The existing higher deficit takes us out to the point where the entitlement systems go into permanent negative cash flow.? This means that the US budget is in a structural deficit for as far as the eye can see, fifty years or more, absent changes to entitlements.”
He looked at me and commented that it would be the job of a later administration.? No way to handle that now.? To me, the answer reminded me of what I say to myself when I go on a scary ride at Six Flags with my kids.? There is nothing we can do to change matters.? The only thing to adjust is attitude.? So, ignore the fact that you are afraid of heights, and enjoy the torture, okay?
Would that I could do that with the present situation.? The long term problems are too numerous, and the present crisis saps attention from what is arguably a larger problem.? Medicare, Social Security, unfunded Federal pensions and retiree healthcare, underfunded state pensions and unfunded retiree healthcare, and underfunded corporate pensions (flowing to the PBGC) are the crisis of the future.? We are talking underfunding and debts equivalent to 4x GDP in total.
The deficits may be helping out areas of our economy for which there is already too much capacity — autos, banks, housing, but isn’t aiding the parts of the economy that don’t have excess capacity.? The one advantage to Americans is that a decent amount of the debt is absorbed by the neomercantilists, who will get paid? back in cheaper dollars (if at all) than the goods that they provided originally.
This all feels like the Japan scenario.? Low interest rates, low growth if any in non-protected sectors, soggy debt-laden protected sectors, excess capacity in areas not salable to the rest of the world, high government debt, and a demographic crisis.? Also speculation using cheap leverage for carry trades.
I’ll try to tie this up in another post or two.? Sorry if this is verbose.
Now, Treasury responded to me, thanking me for the list, but said that the mainstream media bloggers already have access.? Fine with me — I was just gauging talent and reach.
The Nature of a Liquidity Trap
Go back in history over the last 25 years.? How did the Fed manufacture recoveries?? They lowered interest rates enough so that borrowers would be willing to borrow and refinance assets that had cash flow streams that were not financable in the higher interest rate environment, but financable in the lower interest rate environment.
With each successive rescue, interest rates at the trough were lower than before, inviting borrowers that were increasingly marginal to buy assets, borrowing money at cheap rates to pay them off over time.? We thought we saw the bottom, 2002-2004, but no.? The Fed Funds rate can go to zero, and what’s more the Fed can buy longer dated Treasuries, Agencies, and Mortgage Bonds, lowering interest rates on the longer end of the yield curve.? This allows even more marginal borrowers to buy assets. If they face some hiccup in their cash flow, they will default, and quickly.? If you doubt this, consider the high currently expected rate of default on FHA loans originated over the last two years.
Yes, low rates can get them to buy, but it cannot get them to hold on.? But wait, these are criticisms of the Fed, not the Treasury.? Mostly so, but what of the expensive housing tax credit? and cash for clunkers.? Those belog to the Treasury.? They are not economic programs — the costs far outweigh the benefits.? But wait.? Those shouldn’t be pinned on the Treasury; Congress, bought and paid for, are pushing these programs on behalf of their lobbyists.
If so, where is the administration to shame Congress over such behavior?? Where is the President who should press for a line-item veto?? (I like Wisconsin’s version. 😀 )? Let the Treasury, backed by Obama, ascend to the bully pulpit, and say that such programs are a waste of taxpayer dollars.
The Fed and Treasury have been able to touch of a speculative rally in financial assets, which benefits financials, but with weakness in? end-user demand, the lower rates do nothing to stimulate investment in plant and equipment.
All that said, there are three things that could go wrong here:
Contrary to the expectations of the Fed, inflation could rise, and cause the Fed to tighten.
All of the excess dollar claims could lead to greater depreciation of the dollar.
Defaults could cause credit spreads to widen.
Those have not gone wrong yet, but they are all threats.? More tomorrow, when I discuss difficulties with entitlement programs.
Bond indexes are what they are.? They represent the average dollar invested in the bond markets.? Those that say that the indexes are flawed miss the point.? Indexes represent the average return of an asset class, with all of its warts and wrinkles.? That is the nature of an index; it earns what the asset class as a whole earns.
So what if big issuers dominate the index?? The average dollar in bonds reflects that.? Do you want to take a bet against the average?? You probably do, and I do as well.? But it is not the purpose of an index to make that bet, so much as to facilitate that bet for active managers.
I appreciated the book The Fundamental Index ? Arnott did us a favor by writing it.? The book shows how to do enhanced indexing off of fundamental factors.? (A pity that the book went public at the point where most of those factors were overpriced.)
The trouble with enhanced indexing is scalability.? Suppose Arnott?s fund and those like it grew large relative to the market as a whole.? The components of his strategy that are smallest relative to their total market size will get bid up disproportionately.? Eventually they will not be a favored investment of the strategy, and as they move to sell, they will find that they are large holders of something the market is not so ready to buy.? As the price goes down, perhaps it becomes attractive again. Perhaps an equilibrium will be reached.
One thing is certain, though.? The non-enhanced index can be held be everyone.? The enhanced index will run into size limits.
What then for bond ETFs?? Are they chained to inferior indexes? ?No.? By their nature, bond indexes are almost impossible to replicate perfectly because of liquidity constraints. Many institutional bond investors buy and hold, particularly for unique issues.? That?s why indexes are constructed out of liquid issues which will have adequate tradability.? Who issues those bonds?? The big issuers.? It is not possible to create a scalable bond index in any other way, and even then, there will always be some bonds in the index that are impossible to find, and/or, because they are index bonds, they trade artificially rich to similar bonds that are not in the index.
Almost all bond indexers are enhanced indexers, because they don?t have enough liquidity to exactly replicate the index.? Instead, bond indexers try to replicate the factors that drive the index, with better performance if they can manage it.? That?s where choosing non-index bonds that are similar in characteristics, but have better yields comes in.? That is the value of active bond management; it does not mean that the indexes are flawed, but that there are ways for clever investors to systematically do better, that is, until there are too many clever investors.
Pricing Issues
Morningstar prepared this piece on pricing difficulties with bond ETFs and open-ended bond funds.? Yes, it is true that many bonds don?t trade regularly, and that matrix pricing gives estimates for prices on bonds that have not traded near the close, where an asset value must be calculated.
Remember the scandal over mutual fund front-running?? In that case, stale pricing off of last trades enabled clever connected ?investors? to place late trades where the calculated NAV was far away from the theoretically correct NAV (if assets traded continuously).? In order to calculate the theoretically correct NAV (which the late traders did in order to make money), the mutual funds had to engage in a form of matrix pricing, adjusting the last trades to reflect changes in the market since each last trade until the close.? Far from being inaccurate, matrix pricing is far superior to using the last trade.
I will take the opposite side of the trade from the Morningstar piece.? Markets are not rational, especially bond ETF investors.? I trust the NAV more than the current price; matrix pricing is complex, but it is pretty accurate.? Yes, for some really illiquid, unique issues, it will get prices wrong, but that is a tiny fraction of the bond universe.? We can ignore that.
Rationality comes to bond ETFs when sophisticated investors do the arbitrage, and create new ETF units when there is a premium to the NAV, or melt ETF units into their constituent parts when there is a discount to NAV.? That pressure places bounds on how large premiums and discounts can become.
The more specific the bonds must be to create a new unit, the harder it is to do the arbitrage, and the higher the level of premium can become before an arbitrage can occur.? If a less specific group of bonds can be delivered to create a new unit, i.e., the bonds must satisfy certain constraints on issuer percentages, issue sizes, duration [interest rate sensitivity], convexity [sensitivity to interest rate sensitivity], sector percentages, option-adjusted spread/yield, etc., then arbitrage can proceed more rapidly, and premiums over NAV should be smaller.
So, when there are large premiums to NAV, it is better to sell.? Large discounts, better to buy.? Of course, take into account that short bond funds should never get large premiums or discounts.? If they do, something weird is going on.? Long bond funds can get larger premiums and discounts because their prices vary more.? It takes a wider price gap versus NAV before arbitrage can occur.
As for cash creations, those that run the ETF could publish a shadow ETF price, which would represent the price that they could create new units themselves, taking into account how they would like to change the ETF?s positions in order to better outperform while matching the underlying characteristics of the index.? That shadow ETF price could not be a fixed percentage of the existing NAV.? It would have to vary based on the cost of sourcing the needed bonds.? This would run in reverse for cash-based redemptions, which would only likely be asked for when the ETF was at a discount.? Better for the fund to do some modified ?in-kind? distribution, agreed to in advance by the sophisticated unit liquidator.
Derivative Issues
Well, if there?s not enough liquidity in the bond market to accommodate our desired investment, why not create it synthetically through credit default swaps?? That might work, but if the bonds are illiquid, often the derivatives are as well, or, the derivatives trade rich to where an identical bond would trade in the cash market.? There is also credit risk from the party buying protection on the default swap; if he goes broke, your extra yield goes away, at least in part.
I don?t see derivatives as being a solution here, though they might be helpful in the short-run while waiting to source a bond that can?t be found.? Derivatives aren?t magic; liquidity comes at a cost, and some of those costs aren?t obvious until a market event hits.
Also, I would argue that the rating agencies are better judges of creditworthiness on average than the prices of credit default swaps.? Though rating agencies should be examined for their conduct in structured securities, their record with corporates is pretty good.? The rating agencies do fundamental research; yields do reflect riskiness, but markets sometimes wander away from their fundamental moorings.? Derivatives can trade rich or cheap to the cash market for their own unique reasons.? Same for bond spreads ? just because one bond has a higher spread than another similar bond, it does not mean that that bond is necessarily more risky.
When I was a corporate bond manager, I would occasionally find bonds that yielded considerably more than others of a given class.? My job, and the job of my analyst was to find out why. ?Often the bond was not well known, or was a better quality name in a bad industry.? On average, spreads reflect riskiness, but in individual situations, I would rather trust the judgments of fundamental analysts, including the rating agencies, though private analysts are better still.
So what should I do in the Current Environment?
I don?t think we are being paid to take credit risk at present, so stay conservative in bonds for now.? Specifically:
Underweight credit risk.
With equities, stress high-quality balance sheets, and stable industries.
Underweight financials, particularly banks and names that are related to commercial real estate.
GSE-related residential mortgages look okay.
TIPS don?t look good on the short end, but look okay on the long end.
Be wary of paying premiums on bond ETFs? and maybe look at some closed-end funds that trade at discounts.
The yield curve is steep, but that is ahead of a lot of long supply coming from the US Treasury.? Stick to short-to-intermediate debt, and wait for supply to be digested.? After that, maybe some long maturity positions can be taken as rentals, so long as inflation does not take off.
Diversify into foreign bonds, but don?t go crazy here. ?The Dollar has run down hard, and opportunities are fewer.? (I will have a deeper piece on this in time, I hope.)
This is a time to preserve capital, not reach for gains.? Don?t grasp for yields that cannot be maintained.
PS — Thanks to the guys at Index Universe and Morningstar for the articles; they stimulated my thinking.? I like both sites a lot, and recommend them to my readers.? The articles that I cited had many good things in them, I just wanted to take issue with some of their points.
1) Perhaps the US Treasury is getting a few things right.? Let’s start with lengthening the average maturity of Treasury debt.? I have backed this idea in the past.? It is worthy to note that zero coupon yields peak out around 20 years out, and then start declining.? It is quite possible that debt longer than 30 years might price at a discount to 30-year debt, if for no other reason than there is a demand for longer debt as an asset to fund longer liabilities with seeming certainty.
The US Treasury is finally getting some sense in this matter, and is looking to lengthen their maturity profile.? Good for them; let’s see if foreign investors are willing to take down longer-dated dollar-denominated debt.
4) The efficient markets hypothesis did not mean that market prices are always right, as if we hit that evanescent neoclassical equilibrium.? No, prices are always wrong to some degree, but that does not mean it is easy to recognize the mistakes.? So I limitedly back Jeremy Siegel, who says that the efficient markets hypothesis was not to blame for this crisis.? That said, common misunderstandings of the EMH did affect the crisis, because markets do self-correct, but over years and decades, not months or days.
5) If you had the ability to ask one question to Tim Geithner, Secretary of the Treasury, what would it be?? I have my list, but maybe I am off base.? As I close for the morning, here are my questions:
Haven’t low interest rates boosted speculation and not the real economy?
We are looking at big deficits for the next seven years, but what happens when the flows from Social Security begin to reverse seven years out?? What is your long-term plan for the solvency of the United States?
We talk about a strong dollar policy, but we flood the rest of the world with dollar claims.? How can we have a strong dollar?
None of your policies has moved to reduce the culture of leverage.? How will you reduce total leverage in the US?
Why did you sacrifice public trust that the Treasury would be equitable, in order to bail out private entities at the holding company well?? People now believe that in a crisis, the government takes from the prudent to reward the foolish.? Why should the prudent back such a government?
If we had to do bailouts, why did we bail out financial holding companies, which are not systemically important, instead of their systemically critical subsidiaries?
We are discussing giving tools to regulators for the tighter management of the solvency of financials.? There were tools for managing solvency in the past that went unused.? Why should we believe the new “stronger” tools will be used when the older tools weren’t used to their full capacity?? (The banks push back hard.)
I doubt that I will get a chance to have those questions answered, but who knows?? From Quantcast, I know that some at the US Treasury and the Federal Reserve (I have my own set of questions there) read my blog regularly, so I leave it up to them ponder my questions, whether I ever get answers or not.
After the last article on this topic, you would think that they would take me off of the mailing list.? But no.? Wait!? How did GTX Corp do after I wrote my article?
In short, when I wrote, the price went down temporarily, and then rebounded as the flyer advertising GTX circulated among the uneducated masses.? Since that time, the price is down ~90%.
If the advertising group pushing GTX Corp had any self-awareness, you would think they would take me off of their mailing list.? Sad to say, I have a new microcap stock to share with you:? Bonanza Goldfields Corp. [BONZ]
In an era where many fear inflation, an appeal to gold has credibility, and could draw those who think they missed out on the move upward.? The flyer has many evocative images — gold coins, gold bars, etc.? The aura of wealth is palpable.? They appeal to the troubles at present, and suggest that gold is the solution, and that the price of gold will rise as a result.
Because I don’t want to be sued, I am not identifying the researchers — I call them ABC and XYZ.
They give the sense that there are very promising finds of gold to be made from Bonanza Goldfields.? These claims are made in big type, while in small type, the following is written (yes, no paragraphing):
IMPORTANT DISCLAIMER: This paid advertising issue of ABC Research (hereafter “ABC Research”) does not purport to provide an analysis of any company’s financial position and is not in any way to be construed as an offer or solicitation to buy or sell any security. ABC Research is a paid advertiser. OTCBB: BONZ is the featured company. XYZ Inc managed the publishing and distribution of this publication. XYZ Inc is a financial communications media company that disseminates information via paid advertisements. Although the information contained in this advertisement is believed to be reliable, XYZ Inc and its editors make no warranties as to the accuracy of the description of any of the content herein. The information contained herein is being republished from publicly disseminated information issued by third parties regarding BONZ and are presumed to be reliable, but neither XYZ Inc Inc or their editors accept any responsibility for the accuracy of such information. Neither XYZ Inc, nor any of their principals, officers, directors, partners, agents, or affiliates are not, nor do we represent ourselves to be, registered investment advisors, brokers, or dealers in securities. Readers should independently verify all statements made in this advertisement. XYZ Inc, as well as various affiliated companies and vendors have received and managed a total production budget of $1,300,000 for this advertising effort and will retain, over and above the cost of production and publication, any amounts that remain as additional compensation for production services relating to the advertising and publishing efforts. This advertisement was not paid for by BONZ or its management. Please make special note that XYZ Inc, their respective principals, officers, directors, shareholders, stakeholders, creditors, partners, agents, or affiliates own shares of BONZ and intend to sell all of their shares in any company profiled at any time, be that before the date of a profile, during the date of a profile, or at any time after the date of a profile, as has been the practice of XYZ Inc, and their related parties on many previous occasions. Past performance does not guarantee future results. The information contained herein contains forward looking information within the meaning of Section 27 A of the Securities Act of 1933 and Section 21 E of the Securities Exchange Act of 1934, including statements regarding expected continual growth of the featured company. The information contained herein includes forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Reference is made in particular to the description of BONZ’s plans and objectives for future operations, assumptions underlying such plans and objectives and other forward-looking statements included in the information provided. Such statements, which contain terms such as “expect”, “believe”, “anticipate”, “suggest”, “plan”, “indicate” and similar terms of uncertainty, are based on management’s current expectations and beliefs and are subject to a number of factors and uncertainties which could cause actual results to differ materially from those described in the forward-looking statements. All statements relating to operational results are hereby qualified in their entirety by the company’s filings, including its financial statement filings, under the Securities Exchange Act of 1934. Do not base investment decisions on this advertisement. We assume no responsibility for any use or misuse of this material. Consult your investment advisor and do your own due diligence before making any investment in this or any other securities. This report is for INFORMATIONAL PURPOSES ONLY? THIS IS NOT INVESTMENT ADVISE!!!
The grammatical and other errors in the statement are theirs.? But what do we learn from it?
This isn’t a security analysis, much as it would appear to be otherwise.
ABC Research paid $1.3 million to distribute this advertising.? BONZ did not pay.
XYZ owns shares of BONZ, and may sell them at any time.? They have done so with prior companies advertised in the past.
What we don’t learn is what relationship ABC has to XYZ.? I can find ABC on the web, but I can’t find XYZ.? My guess is that ABC and XYZ are affiliates, but I can’t prove that.? Otherwise, why would ABC pay so that XYZ could benefit from the $1.3 million payment, as well as sell into a rising market for their shares?
The “important disclaimer” was printed in teensy 5 1/2 point type in long lines, making it difficult to read.? They weren’t interested in giving clarity.? Where did they offer clarity?? In the big type, often with special coloration or highlighting:
OTCBB: BONZ? This GOLD stock is SET to SKYROCKET!!! BONZ could bring up to 600% to your portfolio in the next two weeks.? PULL UP STOCK QUOTE NOW
ABC’s latest stock profile featured OTCBB: BONU? The stock skyrocketed from $0.25 to $3.5 for two weeks in August 2009.? OTCBB: BONZ will be an even bigger winner.
OTCBB: BONZ BONANZA GOLDFIELDS CORP.? THE NEXT BIG GOLD STOCK PICK WITH 200-500% UPSIDE POTENTIAL!
GOLD IS AT ALL TIME HIGH We believe that gold will hit $2000 per ounce soon and we believe that OTCBB: BONZ will follow the Gold Trend an could hit $2 PER SHARE!!
OTCBB: BONZ COULD BE ONE OF THE TOP GOLD PLAYS OF 2009
BONZ means $$$$ for your portfolio and HUGE profits!!!
Buy OTCBB: BONZ TODAY, IT’S WORTH MORE THAN GOLD!!
AGGRESSIVE BUY & HOLD TO $2.90
There’s more, but that’s most of what they wrote in big type to attract the attention of people.? In medium sized-type, the analyst/advertiser spins a tale of how this company has promising land, mainly located in Arizona, where they have done some assays and found some gold, silver, lead, zinc, and copper.? They claim to have an experienced team of people to exploit the resource.
BioNeutral
Before I deal with BONZ, what of the stock BONU that they predicted such gains on — gains that BONZ will exceed?? They included a graph that looked like this for readers:
The company’s name is BioNeutral Group, Inc. Their corporate decription reads as follows:? BioNeutral Group, Inc.manufactures specialty chemicals.? The Company produces chemicals that can neutralize environmental contaminants, toxins, bacteria, viruses, and spores.
But why show such a small graph?? How has BioNeutral Group, Inc. done over the last 12 months?
My, but that was selective.? If I may, it looks like ABC’s report led to a temporary bump in BONU, much as it did for GTXO.? My guess is that better informed people who know the promotion is going on profit at the expense of the rubes who believe their report.? I have not researched BioNeutral, but my guess would be that the stock price would continue to decline, like that of GTXO.
Their auditor is not a major auditor, but they still could not issue a “going concern” opinion for the last two years.
The firm has negative net worth and negative net working capital.
The firm has one asset valued at $99,000, their mining claim, and petty cash.
They have no revenues, and have lost money for the past two years.
They do not have the resources to explore/exploit their mining claim.
From the S-1:? We currently have no employees except the board of directors and officers. We have no employees other than our officer and director as of the date of this prospectus. Our board members currently devotes approximately 5 hours per week to company matters and after receiving funding, they plan to devote as much time as the Board of Directors determines is necessary to manage the affairs of the company. There are no formal employment agreements between the company and our current employees. We conduct our business largely through consultants.
From the 10-K: As of fiscal year end June?18, 2009 the Company had 1 employee.
From the S-1: During the period ended June 18, 2008, the Company granted to members of the Board of Directors, 6,997,900 shares of common stock valued in the aggregate at $69,979, for service rendered to the Company outside of their responsibilities as members of the Board of Directors and were valued concurrent with maximum price the common stock was sold in a private placement.
During the period ended June 18, 2008, the Company issued 3,302,100 shares of its common stock for $85,000. The shares were issued to third parties in a private placement of the Company?s common stock. ?The shares were sold throughout the period ended June 18, 2008, at a range between $.01 – .02 per share. (DM: giving them a small gain.)
The risk factors are voluminous, consistent with a company that doesn’t have much going on.
None of the Board of Directors have any experience in mining listed; the advertisement suggests extensive management experience (over 120 years), though it is silent about mining management experience.
Officers own 66% of the firm, as of the date of the 10-K.
There are three entities that have provided the financing: Gold Exploration LLC, who sold them the parcel, and gets some royalties.? Taylor Invest & Finance and Venture Capital International have provided financing, and were sellers of shares at the IPO (look at page 11 — also note that there are multiple entities selling stock controlled by the same people.? Odd.)
Bonanza Goldfields raised no proceeds in the IPO.
I’m not sure I am reading it right, but it looks like Taylor Invest & Finance and Venture Capital International would end up with a large amount of the company if they converted their financing to shares.? The wording is vague.
I also can’t explain why “In June?2008 a total of 3,302,100 common shares were sold?to public non-U.S. investors, for an average price of $0.026 per share.”? These same shareholders sold it all for the same price in April of 2009.? The only possible benefit I can see is that it somehow cements relationships with Taylor Invest & Finance and Venture Capital International.
They entered into more financing arrangements with Taylor Invest & Finance, and Advantage Systems Enterprises Limited (another seller at the IPO).
They split the stock 7 for 1.
From the 10-K: At June?18, 2009, there were 72,100,000 shares of common stock of Bonanza outstanding and there were approximately 21 shareholders of record of the Company?s common stock. That is a small number for just having done an offering, particularly when the S-1 said there were just 19 shareholders then.
This filing may connect Mr. Vippach of Venture Capital International and a Mr. Soullier, who might be related to the 40% owner Rose Marie Soullier.? That’s just a curiosity, though; I have no idea if it means something.
The stock did not start trading until May 5th, 2009, long after the IPO in September 2008. It traded around 65 cents a share, a considerable amount above the IPO price.? The current price of 30-33 cents gives the firm a market cap of around $18 million.? Off of the recent financings, they are looking to explore their mining interests.? They have also bought two more interests.? They have enlisted Gold Exploration LLC to help them analyze the property.? (Why should Gold Exploration LLC sell property to them, and then help them analyze it?? Weird.)? Also odd is the cancellation of shares of the #2 shareholder, seemingly for no compensation.? Gold Exploration, LLC, or at least Steve Karolyi, a co-founder, has had dealings with three other microcap miners, Mariposa Resources, Firstar Exploration Corporation, and Zone Mining (now delisted).? I don’t have enough data to say whether it seems fishy or not.
Summary:
There’s a lot of weird stuff here, and a lot of stuff that I don’t know:
How does a company with practically no assets, no revenues, and a negative net worth support a $18 million market cap?
How are ABC and XYZ related?? What does ABC Research get out of this?
Do they have any relationship with BONZ, or those with economic interests in BONZ?
How much of BONZ does XYZ own?
How are the various financiers related?
Is Gold Exploration LLC just a service provider?
The advertisement offers no justification for its target prices.
The advertisement uses gold as a hook, because it is hot now.
Note: here is a penny stock feed complete with twitter: they think it is going up.? I would, too, looking at the charts, and looking at the advertisement.? But I can’t speculate on stuff like this; it’s unethical.? Stay away — do not go long or short.
As I closed the prior piece — Buyer beware, and don?t listen to strangers giving you advice.? Cultivate networks of knowledgeable friends who are trustworthy, and avoid getting taken for a ride by slick-talking (writing) hucksters who pitch clever ideas to you.? Do your work, and buy cheap, boring ideas like I do.
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One note in passing: shouldn’t the SEC have some interest in this sort of advertising?? I mean, at least have a rule that says that legal disclaimers must be in type larger than the largest font size otherwise in the document, and with no other alterations to affect readability.? Then perhaps it would be harder to fool people through advertising that pretends to be research.
Full disclosure:? No positions in any securities mentioned.? This is my opinion only, and not that of my employer.? I’m only interested in honesty in the markets.
OTCBB: BONZ BONANZA GOLDFIELDS CORP.? THE NEXT BIG GOLD STOCK PICK WITH 200-500% UPSIDE POTENTIAL!
Analyzing currencies is weird, and most people don’t get it.? Sometimes, I think I don’t get it.? There is nothing fixed in our economic world, no fixed measure of value.? Everything trades against everything else.? Currencies exist to make the trading easier.? Imagine a matrix that is millions by millions, with trillions of exchange rates for one good or asset against another.? With currencies, it simplifies.? Each nation prices out goods and assets in their own currency, and then currencies trade against each other, subject to arbitrage with commodities, and commodity-like assets.
Anyone who has read me for a while knows that I am not a bull on the US Dollar.? But where I part ways with the grizzly bears (call me a teddy bear 🙂 ), is that the fundamental accounting identities must be maintained.? Whatever country of our world has the status of reserve currency must issue debt, and a lot of it, that other countries can invest in to park their idle cash balances.
It does not matter what currency crude oil trading, or any other trading, is denominated in; it does matter in what currency the proceeds from the sale of crude oil is invested in.? So long as the US runs current account deficits, foreigners must acquire US assets in order to fill in the gap.? In the past that has mainly been bonds — agency, mortgage, corporate, but increasingly Treasury notes.
It is not that easy to abandon the US Dollar.? Where do you go?? The yen will suffer for years as Japan heads into demographic decline and large structural budget deficits. The Euro is still an experiment; there are many pressures on it; its survival is mot assured. Nothing else is large enough or stable enough, or mature enough to run the deficits necessary to have the debt markets, to be the global reserve currency.? As an example, China does not want to run deficits, nor is its financial system strong enough to bear the wear and tear of global use of its currency.
So, when reporters write pieces indicating the imminent demise of the US Dollar, I don’t buy their arguments:
If the money is not invested in US Dollar investments, where will they invest? That is the question.
Now, there are other issues. China? could queer global trade by asserting that entities in China could default on obligations from derivative contracts and not worry about it.? Why is this big?? If a major country does not respect contract law, that country will not be respected in global trade.? Granted, China is a creditor, not a debtor on net, but the ability to transfer capital is paramount in the global economy, and if China will not honor contracts, that will bite them.
My view is that the US is in a Japan-like funk, which it will not rise out of for years.? I don’t think the Fed will move aggressively — they will be timid.? It is easier to argue to Congress that they did their best but conditions were severe, than to argue that they headed off inflation, but many people were unemployed.
Unless Europe moves to a full political union, or China frees its economy, there is no real competitor to the US Dollar.? Yes, the dollar will likely decline over the next decade, but it will not be likely to lose its reserve status, unless a commodity standard currency comes into being.
I wrote the following this morning for Finacorp clients:
“One of the keys to understanding the current environment is that there is a lot of financial liquidity, which obscures a lack of demand for products that are not staples. With unemployment so high, and perhaps worsening, it is difficult to invest in new plant and equipment, but easy to build up excess liquid assets as protection against further decay. It is also then easier to refinance debts, or buy high yielding debt, and clip a spread, hoping things don?t blow up again.”
Let me phrase it another way.? So the Fed comes in and offers cheap liquidity to financial institutions.? Does that mean the financial institutions will now offer loans to industrial corporations?? More of the loans will go to those that are buying “cheap” high yield debt, until the yields make no sense versus the bad default climate for companies that have issued high yield debt.
Most of what the Fed has done has been to raise? the prices of financial assets for now.? Unfortunately, the the Fed is not big enough to do that for most residential housing in America.? For those that have mortgages, sorry, half of you are under water, where under water is defined as higher than a 90% LTV.? Once sale costs are counted in, a 90% LTV is a close to a breakeven.
For the US government, together with the semi-independent Fed, it is relatively easy to lower interest rates, which percolates through the lowest risk sectors of the economy, so long as the dollar does not fall apart.
The Fed can manufacture financial speculation easily, but has a harder time encouraging investment in plant and equipment.? Much of that depends on the rest of the world.? There are no strong economies now, and most countries need to pay down debts.? Debt-based financial systems are more fragile than equity based systems.? Things may be weak for a while as we head back to an equity-based system.
1)? You hear me talk about this more than most, but liquidity risk needs more emphasis.? This is true whether you are a retail or institutional investor.? As the old saying goes, “Only invest what you can afford to lose.”? The basic operations of life require liquidity.
That even applies to the abstract mathematicians who developed much of modern finance.? The moment they assume a simple arbitrage argument, it implies that liquidity is free, or nearly so, in the markets.? I remember asking questions of my professors over Black-Scholes 25 years ago, because equity markets did not trade continuously, except for large companies.
My view is that introducing liquidity risk will be difficult for academic finance, because it will blow apart the simple models that they need in order to write their research.? Once markets do not trade continuously, the math gets tough.
2)? Insiders are selling, should you worry?? Perhaps a little, but I would wait until the price momentum starts to fail.? Like value investors, insiders tend to be early.
3)? What works in a time of rising leverage will not work well when leverage is decreasing.? Or, a strategy that requires liquid markets does not so well in a time of deleveraging.? Consider Citadel, then.? The period from 1991-2007 was pretty care-free.? What crises occurred were not systemic, and were quickly snuffed out by the Fed, as it edged us closer to a liquidity trap.? In 2008, the trap was sprung and Citadel had a lousy year.? Amid the carnage, they were forced to sell into? falling market.? Now they are running at reduced leverage, and planning products that would have been smart eight months ago.
4)? Average retail investors don’t understand regulated investments well enough to invest in them.? It would be stupid to allow them to invest in hedge funds, then.? If we would do such a thing, then deregulate the simpler investments first, telling people that they are on their own, the ineffective SEC is being disbanded, and that “caveat emptor” is the only risk control remaining.
I can’t see that happening in my lifetime.? The nature of American culture abhors implicit fraud, and thus we regulate most of those that take money and offer uncertain promises, when those offering the money don’t have much.? (The culture abhors little investors being fleeced by bigger institutions.)
5)? Auction rate preferred securities — when I was younger, I wondered how they worked.? By the time I figured that out, the market failed.? Now the lawsuits fly.? Yes, they were marketed as money market equivalents, but none of them made it into money market funds.? Now, having read many of the prospectuses, the risks that eventually emerged were disclosed in advance.? Few believed them because it had worked so well for so long.? My view is this — investors needed to read the “risk factors,” and did not.? ARPS were designed to be investment vehicles that could survive a storm, but not a tornado.? Tornadoes do happen, and those that assumed that such volatility would never happen lost.
8 )? After many other crises, junior debt gets grabbed when seniors have rallied a great deal.? The need for yield is significant, much as I think it is premature to buy those junior debts.
9) The same is true for high yield.? When does the rally end? Now?? Typically near a market peak, there is confusion, and a diminution in volume.? I think we are close to the end, but as I usually say, honor the momentum.? If it is still going up, hold it.
10)? This article is a little unusual for me, but it points out something that I often talk about in different terms.? Trees don’t grow to the sky.? In almost any process, the results are not linear as one increases effort, but there comes diminishing returns because improvement is not costless.? Exponential growth meets the constraint that resources are not infinite, and so growth follows more of an S-curve.? So it is with business, and much of finance.
When I wrote What Stories Aren?t Being Told?, I did not expect a big response.? But I got 53 responses, more than double the responses of my next-most-responded-to article.? Many bloggers linked to it, and responses continued on for almost four days.
But after Dr. Jeff’s comment, I decided to write a second piece, What is Going Right? Now, part of that also sprang from an e-mail that Rolfe Winkler sent asking what is going right, but I did it as a kind of test to see if asking for optimism would yield a response.
Alas, but only eleven responses came and a few were negative in nature.? I only received one link.? What should that tell me?? The most obvious answer to me is that people by nature are more inclined to complain than to praise.? Though I could resort to the Bible for proof here, instead I will cite two researchers I first bumped into 28 years ago (before they were cool), Daniel Kahneman and Amos Tversky.? They found that losses delivered roughly three times the pain, when compared to pleasures of an equal-sized gain.? (Side note: this has many applications, and in our day and age, most of them are politically incorrect.? As investors, though, we know it — avoiding losses is a better motivator than seeking gains.? At least, those that avoid losses stay in the game.)
Look, I see it in myself.? I tend toward the negative in this era, because I think it is under-told.? Would it surprise you if you knew that I was one of the more bullish guys in my last three firms (1998-2007)?? But even if under-told, there is something that always makes the bear case sound smarter.? Skeptics almost always seem smarter than optimists.? But, the optimists usually win, except when there is war on your home soil, famine, plague, or extreme socialism.
Where does that leave me?? It leaves me with rules.? I have trading rules.? I have asset allocation rules.? I can lean against something that I think is wrong, but I can’t put all of my weight on it.? I listen to the Sirens, but I tie myself to the mast.? Discipline trumps conviction.
So, to close, I offer an old CC post to illustrate:
I Listen to the Sirens, but Like Ulysses, my Hands Are Tied to the Mast
12/27/2006 2:31 PM EST
When I had dinner with Cody two weeks ago, he asked me (something to the effect of): “If we have so many problems, why are you so net long?”
I told him about a hedge fund friend of mine who let his bearishness drive his macro bets over the last four years. The only thing that has bailed him out is that his analysts are really good stock-pickers… their fund has been in the plus column despite being an average of 25% net short, but not positive by much.
I tie my hands when it comes to asset allocation policy. After determining what I think the neutral policy should be for someone that I advise, I allow myself to tweak it by no more than 10% to reflect my overall levels of bullishness or bearishness. This keeps my emotions from taking over, and protects me and those that I manage for.
Besides, absent a major war on home soil, or a Communist takeover, markets have a tendency to eventually bounce back. (even if the bounce takes 25-odd years, as in the Great Depression). The question is whether one’s asset allocation is conservative enough to be around for the “bounce back.” So, it generally pays to play along with the optimists in the long run. Or, as Cramer has said, the bear case always sounds more intelligent. That can trap bright people who let legitimate fears of something that may happen a ways out get treated as a clear and present danger.
At present I am slightly bullish on the US markets and think that 2007 will produce moderate gains, 5-10%. There are things to worry about, but don’t let it blind you to opportunities that will emerge if disaster doesn’t happen. Instead, diversify. Stocks and high quality bonds. (Maybe even some municipal bonds.) Domestic stocks and foreign. There are ways to reduce risk that don’t cost that much in terms of performance. Use them, and don’t worry about the big, bad event. That event will happen, but it will usually be further out, and less bad than expected.
I am always reminded when I see the myriad negative articles about macro issues that you must be like Ulysses — you have to tie yourself to the mast and plug your ears — if you are really going to make money. The parade of horrible worries is so loud and so seductive that the toughest thing to do is to stay the course. And the toughest thing to do is almost always the most lucrative.
I asked him via e-mail whether he had read my piece, and he said he had not. Quite a coincidence. Before I asked him, though, I wrote this response:
I am always reminded when I see the myriad negative articles about macro issues that you must be like Ulysses — you have to tie yourself to the mast and plug your ears — if you are really going to make money. The parade of horrible worries is so loud and so seductive that the toughest thing to do is to stay the course. And the toughest thing to do is almost always the most lucrative.
At my last firm, we conflated two maxims into: “Great minds think alike, but fools seldom differ.” Jim and I disagree on housing. In this case, though I still have many reasons to be bearish on housing, I don’t let it affect my investing to any great degree. For my broad market portfolio, I still own Cemex, Lafarge, and St. Joe. I even own a mortgage REIT, Deerfield Triarc. I’m not bullish on the consumer, but I still own Sonic Automotive and Lithia Motors.
The point is, it’s too easy to say “I’m too worried about the macro environment,” or, “I can’t find anything cheap enough to buy.” Will there be down years? Yes. Might the first decade of the 2000s have a negative total return? Possible, but unlikely. Like the farmer in Ecclesiastes 11, we have to cast the seed into the muddy spring soil, and not worry about the bad weather that might come. Diversification reduces risk, but not taking risk is possibly the biggest risk of all. The advantage belongs to those who take prudent risks.
Now, after all this, if you still want to worry, the biggest risks among the somewhat likely risks out there a breakdown in global trade and an error in Fed policy. I watch these things, but I’m not losing sleep over them.
PS — regarding Ulysses, he put wax in the ears of his sailors, but he tied himself up so that he could listen to the Sirens, but not do anything… it’s a tough discipline to maintain, but it helps me do better in the markets.
Position: Long CX LR JOE DFR SAH LAD
A very different era, that, but I am now bearish, and Cramer is still bullish.? I try not to change my positions often, and even then, I limit my behavior.? Discipline triumphs over conviction.
— a book that deals with the reality of sovereign defaults over the last 800 years.
